Class Notes (838,006)
Canada (510,619)
Brock University (12,137)
Economics (200)
ECON 1P92 (65)
Lecture

Chapter 28.docx

6 Pages
149 Views
Unlock Document

Department
Economics
Course
ECON 1P92
Professor
Marilyn Cottrell
Semester
Winter

Description
Chapter 28: Money, Interest Rates, and Economic Activity Financial Assets: 1. Money- currency plus checkable deposits 2. Bonds- bought and sold in bond market Bond is a promise to make payments at dates in future. Present value is the current value of one or more payments or receipts made in the future- the (discounted) present value (PV) of the bond. The present value of any asset [e.g. bond] that yields a stream of payments over time is negatively related to the interest rate. Present Value and Market Price  PV of an asset is the highest price someone would pay to own the future stream of payments from the asset.  Any price lower than the present value creates excess demand for the asset- drives up the assets price.  The equilibrium market price of an asset is the PV of the income stream that the asset produces. The Interest Rate Market Price  Negative relationship between interest rates and asset prices 1. If interest rate falls Present value of an asset with a given income stream will rise 2. A rise in market price of an asset with a given income stream Is equivalent to a decrease in rate of return earned by the asset.  Downward sloping money demand curve  At any given time the money supply is constant  Equilibrium is at I* where MD=MS MS>MD: high rates of interest  Excess supply of money- buy bonds  Capital gain  drive down cash balances  i1 decrease -> i* Pb increase At a low rate of i  Expect i to rise  Excess demand for money  Sell bonds  Avoid capital loss  Drive up cash balances  I increase -> i* Pb decrease Stocks and Bonds Income-earning assets:  Bonds (debts) generate a stream of interest payments  Stocks (equity) generate a stream of dividend payments Demand for money:  Lump all income-earning assets as ‘bonds’ “Bonds”  Earn interest “Money”  Earns no interest The Demand for Money  Money balances you want to hold Opportunity cost of holding any money balance  Is interest earned if money used to purchase bond Three motives for holding money:  Transactions motive  Precautionary money  Speculative money The Transactions Motive Transactions balances  Money balances held to make payments If GDP is larger  More transactions  Economy holds larger transactions balances If interest rate is higher  Fewer transactions balances held  Interest rate is opportunity cost of holding money The Precautionary Motive Precautionary balances  Held to protect against uncertainty of the timing cash flows If interest rate is high  Fewer precautionary balances are held  Higher opportunity cost The Speculative Motive Speculative balances  Held because of uncertainty of prices of financial assets  Bonds If interest rates change  Bond prices change  Rate of return uncertain Hold money to diversify  Financial portfolio  Reduce risks At higher interest rates  Opportunity cost of holding money rises  Households (HH) and firms hold less money Real vs. Nominal Money Nominal money [M]  Actual amount of money  Currency plus bank deposits Real Money [M/P]  Nominal money divided by the price level  It is the purchasing power of the money If price level rises by 10%  Nominal money rises by 10%  Real money is constant Real and Nominal Money Balances Change in price level:  Does not change demand for real money balances  Does affect demand for nominal money balances Ceteris paibus, nominal demand for money balances varies in direct proportion to price level Monetary transmission mechanism:  Changes in supply and demand for money affect aggregate demand Three Stages: 1. Change in money demand or supply changes equilibrium interest rate 2. Change in interest
More Less

Related notes for ECON 1P92

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit